Promise of a Turn Around (Is BAC a Buy, Sell or Hold in 2013?)
Is it possible that both Bank of America (Stock: BAC) and the U.S. banking sector have seen the worst of their 'bad days'? Given some of the recent positives in the U.S. economy, and the less than expected negatives in Europe, should investors now be more confident of a major turnaround in the fortunes of BAC and its industry peers?
Let's review some of the facts that have contributed to the +81% rise in BAC stock over the last 1 year.
So what are the fundamental reasons for this turnaround? BAC reported much improved credit quality and capital ratios in Q3-2012. Also, dire predictions of a decline in its trading revenues, and forecasts of much lower debit card revenue did not come to pass. Certainly, expenses rose for BAC, but so too did they rise for many of its peers.[newsletter1][/newsletter1]
While Q3-2012 net income of $340M was a sharp decline from the $6.232B in Q3-2011, BAC's loan loss provisions for the quarter declined to $1.774B, from $3.407B in the same quarter last year.
There have also been some headline impacts that could explain the recent surge in the stock price. The settlement of the Countrywide Financial legal battles, while not yet finalized, has been a catalyst for easing other legal woes facing the bank. Surprisingly, the announcement of a plan to retire some junior debt and preferred stock, in exchange for issuing additional common stock, did not dampen investor sentiment in the stock.
As a result of the recently announced deal with Fannie Mae, investors could expect BAC to reduce provisions for mortgage repurchases in 2013. Also, should there be an easing of downward pressure on longer-term U.S. interest rates, that too will bode well for BAC, both in the short and intermediate term.
Since late 2010, the stock broke below its 200-day Simple Moving Average (SMA) support levels, and has been trending lower ever since, largely as a result of the effects of the financial crises, BAC's exposure to the U.S. housing market, and some persistent legal woes. This down-trend has reversed since mid/late 2011, and the stock has been performing comparatively well, gaining steadily in upward momentum.
Now that the stock is approaching its 50-day SMA, it will be interesting to see if it finds resistance at that level. Based on the uptrend we are seeing, we could expect the stock to push through two other resistance barriers over the next 12 months – 90 day SMA ($13.64) and 200 day SMA ($14.30) – on its upward march.
See also: Top Ten Bank Stocks for Investors
Based on a 5-year average, BAC trades at significantly lower PEG and Forward PE multiples, which makes it much less expensive than it has been historically. With a Forward PEG of 1.4, BAC trades at a discount of approximately 37% to the Banking industry as a whole. However, while it has historically (over a 5-year period) traded at a 44% premium to its Trailing P/E, BAC now trades at about 65% premium compared to its peers in the industry.[newsletter2][/newsletter2]
What are the Risks?
The biggest risk to BAC's upward momentum could be a significant stalling of, or downward momentum in, the U.S. economy. This could have a huge impact on loan growth, which will obviously have an impact on the Bank's bottom line. The unenviable situation in Europe, the upcoming debt ceiling deadline in the U.S., global low-interest rate climate, and more stringent regulatory environments might also take their toll on the stock. The appearance of green shoots in the U.S. housing industry may, however, be a silver lining.
The bank could also face significant headwinds as a result of any residual and lingering legal challenges that it could face, due to mortgage and foreclosure related issues. While causing a drain in the bank's financial resources, such litigations have the impact of distracting management's attention from the key business at hand – business development and creation of shareholder value.
The Bottom Line
For the moment, BAC would be a HOLD. The rationale for this recommendation would be some of the impending risk scenarios highlighted above. Investors currently holding the stock are seeing a slow but gradual recovery. Selling now would therefore be unwise.
Good luck in your investing,
MarketConsensus Stock Analysis Team
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